With insurance penetration across Asia poised for growth, the evolution of the sector and Asian investors’ increasing search for yield, uncorrelated returns, and a transition to investing in a portfolio context, will increase ILS investment, according to industry executives.
For a number of reasons that includes a lack of awareness and education, limited catastrophe modelling capabilities and historical data, among others, insurance penetration across Asia ranks among some of the lowest in the world.
As a result, insurance-linked securities (ILS) business in the region is in its infancy, but the evolution of the Asian marketplace and the Asian investor, suggests change is on the horizon.
Speaking at the Artemis ILS Asia 2016 conference held in Singapore in July, industry leaders and experts discussed the potential for Asian investors to increase their investment in the ILS asset class, a trend that could help expand the ILS sector and also provide diversification, while offering investors with an uncorrelated return.
Founder of ILS Advisers, a Hong Kong domiciled company that is also the only ILS manager/consultant based in Asia, Stefan Kräuchi, told the audience that the main concern among potential investors is related to counterparty risk.
“They’re first always concerned about the counterparty risk, and being able to assure them that there is not much counterparty risk in those instruments, often is a very important and appealing selling point,” said Kräuchi.
Collateralised reinsurance and catastrophe bonds are the two most dominant sub-sectors of the expanding ILS space and, the nature of the instruments means that the collateral is held upfront in a trust account, or similar, until the transaction has ended and the capital is either returned or not, depending on whether it is triggered or not.
Being fully collateralised from third-party capital markets investors’ means that counterparty risk is very, very limited with ILS transactions, and potential investors should have less of a concern about a party not being able to fulfil its financial obligation.
Over the next ten years or so Kräuchi expects demand for ILS in Asia to grow, something that has been noted by other industry experts that feel the expected increase in insurance penetration will result in greater demand for reinsurance in the region, which, typically results in more of an opportunity for ILS to play a role.
However, Asian investors are evolving too, and while heightened penetration levels may well lead to a spike in ILS demand, the appetite among Asian investors for “yield and uncorrelated returns,” combined with investors beginning to look at investments in a portfolio context as opposed to individually, will also play a part, explained Kräuchi.
“I see this changing as well now, and in that process, investors start to fully appreciate the benefit of ILS as an addition to existing movements inside their portfolio, that ILS can enhance the return while reducing the risk,” said Kräuchi.
Highlighted by the solid performance of ILS instruments during the 2008 U.S. financial crisis, when compared with other alternative asset classes, the uncorrelated return benefits of catastrophe bonds and other ILS structures can offer a stable, albeit currently reduced revenue stream for investors.
At the same time, the broadening base of capital markets investors that operate in the space, and the expanding reach of ILS in terms of geography and peril makes it a very diversifying investment, a feature that is extremely beneficial to any investment portfolio.
Currently, institutional investors in Asia have a strong preference for liquid investments, and favour fund structures such as UCITS and traditional instruments like the 144A catastrophe bond, said Kräuchi.
But as investor comfort rises it’s possible that investors in the region will be open to a more diverse range of ILS investment, which ultimately improves diversification and provides a steady inflow of uncorrelated returns.
Artemis ILS Asia 2016 attendees were also treated to an exploration of ILS liquidity and the workings of the secondary market, which, as noted is of preference to the Asian investor.
The talk was delivered by Steve Emmerson, Head of ILS & Insurance Desk at Tullett Prebon, and provided the audience with analysis and insight into the liquidity of the ILS space, and how this might benefit investors.
Moving away from liquidity, Dr. Mili Eppler, Senior Underwriter at Credit Suisse Insurance Linked Strategies Ltd., discussed how certain ILS features could provide investors with more comfort in investing in the asset class, much like limited counterparty risk does.
“One way we could really enable greater access to alternative capital would be to create products with, for example, parametric triggers, where you remove a lot of the uncertainty about the underlying exposures. I definitely see these types of products as making it easier for us to invest in Asia,” said Eppler.
It’s difficult for investors to have comfort investing in catastrophe-linked re/insurance business in a region that lacks adequate historical loss data and modeling capacity, as the risk of overexposure is so great.
Structures like a parametric trigger eliminate much of the uncertainty that isn’t yet properly understood by modellers and re/insurers, enabling products to be developed that investors should be far more comfortable participating in.
The potential for ILS expansion in Asia is huge, and the message from the market appears to be one of an expected increase in penetration, and ultimately demand for reinsurance and ILS.
Asian investors are evolving at the same time as the marketplace and risk landscape, and would be wise to at least consider an ILS investment as a diversifying, uncorrelated asset class that adds value to their portfolio.